FATCA - The When, the Why, the Where and How

Renowned author and entrepreneur, Mark Twain, once said, ‘tax is a fine for doing well; whereas, a fine is a tax for doing wrong.' Now, the question on hand is which one of the two the Foreign Account Tax Compliance Act (the FATCA) would get unseated! Is it a tax or a fine? Let’s read further to find out.

The FATCA promulgated on March 18, 2010. It was introduced in line with the Hiring Incentives to Restore Employment (HIRE) Act, and the then President Barack Obama signed FATCA into law to help the United States Government, through the Internal Revenue Service (IRS), curb tax avoidance by US citizens and entities on assets held in offshore accounts. FATCA is a comprehensive, and complex arrangement of tenets intended to impose tax compliance upon American citizen regarding assets outside the United States and such citizens are required to report such assets to IRS. Importantly, also, foreign financial institutions are also obliged to comply with the reporting requirements under which these financial institutions have to provide information and details to IRS about the accounts held by such US citizens or non-US entities in which US citizens hold significant ownership.

The Why

As outlined above, the intention of the US government to enact FATCA was to increase transparency for IRS to counter tax evasion by U.S. persons holding investments in offshore accounts. FATCA is a tool to keep a check on US persons who may be investing and earning income through non-US financial entities. FATCA mandates U.S. 'persons' holding foreign financial assets with an aggregate value exceeding US$ 50,000 (US Dollars fifty thousand) to report essential information about those assets on Form 8938. This Form 8938 will be attached and annexed to the taxpayer’s annual tax return. The disclosure requirement mandates taxpayers to report assets held in taxable years commencing after 18 March 2010. For a majority of taxpayers, this disclosure will be the year 2011 tax return which they file in the 2012 tax filing year. Failure by taxpayers to report foreign financial assets on Form 8938 will attract a penalty of $10,000 (and this may be raised up to $50,000 for continued noncompliance after IRS issues notification to the defaulting taxpayer(s)). In cases where IRS notices any underpayment of tax payable on non-disclosed financial assets held by taxpayer overseas, an additional penalty of 40 percent will trigger.[i]

Importantly, the term ‘U.S. Persons’ is a broad category which includes citizens of United States, those residing within the US, holders of US green cards and trusts that are controlled by US Persons. IRS has also set extensive norms, and criteria for banks (domestically as well as overseas) wherein the banking machinery will be required to screen each and all client(s) to determine whether such person(s) falls within the definition of US Person. Foreign entities will get classified as either Foreign Financial Institutions (FFI) or Non-Financial Foreign Entities, and such entities will have to comply with FATCA reporting rules.[ii]

FATCA mandates compliance by US citizens and entities in the following methods:

i. Direct Agreements – agreements between the parties and IRS for compliance purposes; or

ii. Inter-Governmental Agreements (IGAs) – agreements between various jurisdictions and the US.

In the case of the latter, financial institutions in the jurisdictions that have an underlying IGA with the US are mandated to submit the disclosure information to the tax authorities of their respective jurisdictions. The domestic tax authorities would then send the information to the US Treasury to comply with the provisions of their IGA.

However, it’s easier said than done! The demanding role of FATCA compliance primarily revolves around the sanctions that would apply on FFIs that are in breach of compliance with the reporting requirements and disclosures of FATCA. Non-compliant FFIs would have to pay a penalty of 30% of withholding tax on all US-sourced payments.

Further, taxpayers benefitted from IGA during the period in which their government tries to implement the same with the US government. However, this policy of the IRS got revoked on 29 July 2016 on the basis that the Department of Treasury would implement a new list of jurisdictions that had valid IGAs with the US and subsequently, discard jurisdictions that had not yet implemented the same. Therefore, governments can avoid removal from the list by submitting an explanation as to the reasons why they have not implemented the IGA along with a process detailing how the jurisdiction will enforce the IGA in this regard. Subsequently, the Department of Treasury will not strike out the name of that particular country if convinced that the particular jurisdiction has demonstrated a ‘firm resolve’ to implement the IGA. Although, notably, the name of the country may, later on, be removed from the list if they fail to adhere to the norms and timeline which was set out in its explanatory submission to the Treasury.[iii]

Hence, any FFI failing to comply with the above-said provisions of the FATCA will result in FFI paying a withholding tax of 30% of its payments received from a US source. The next cardinal question that arises in this subject is regarding the ambit of the ‘US-source payments.' This scope gets further elucidated with the help of the following instance: US-source payments is set to cover all payments to the non-compliant FFI from a US source such as principal amounts that mature from corporate or government bonds, dividend received from US entities and the like. This element is considered to be a bane in the financial industry since US stocks and bonds have a significant part to plan in the globe’s financial sector.

The When, Where and How

The sanction of imposing a withholding tax amounting to 30% of all US-source payments came into effect on January 1, 2014. To the awe of global economy, gross proceeds that arose from the sale of a US security also came under the scrutiny of this worldwide tax imposition in January 2015. However, the withholding of tax on foreign pass-through payments by FFIs was delayed to 1 January 2017.[iv]

The implementation of the FATCA has proved to be an effective method to suppress the actions of US person who yearned to evade their tax liability by transferring or using financial institutions located outside the US. However, it has also given rise to various issues regarding the implementation procedures that ought to be followed by the US.

The primary concern with the implementation of FATCA surrounds the compliance issues of domestic financial institutions in a broad range of matters including data and consumer protection, anti-discrimination statutes and the earlier withholding tax law of the US. Numerous countries had explicitly made their concern regarding FATCA compliance to be in direct conflict with the data protection and privacy laws that are already in place either in their domestic jurisdictions or in the US itself.

However, this is only the commencement of the large list of issues that pose to oppose the implementation of FATCA. The overall cost of implementing the law is also expected to outrun the anticipated revenue that it is likely to rise. Further, the rationale behind compelling foreign institutions and governments to gather information regarding US citizens and entities solely to transmit them back to the US Government resulted in reactions from financial pundits, some of whom cited this as a ‘decisive’ action. This rationale may also give rise to a predicament whereby foreign institutions and banks may deny US citizens and entities from opening banks accounts at their respective establishments. Another crucial aspect of this issue is the increase in the number of US citizens who are willing to surrender their citizenship due to the mandatory compliance conferred upon them.[v]

Further, the model IGA also mandates a mutual transfer of information from the US Government to the governments of other jurisdictions. However, the significant concern with this provision arises because there does not exist a specific US statute or regulation that permits such reciprocity. The rise in scrutiny regarding the legal validity of FATCA has also stirred controversies and questions in countries such as Canada and Israel; however, the high court of the latter jurisdiction confirmed and permitted the compliance requirements of FATCA subsequently.

Conclusion

The implementation of FATCA is considered to be advancing expediently, although, numerous nations have contended the global impact of the compliance requirements that arise due to FATCA. Certain jurisdictions such as the United Arab Emirates which have been generic tax havens have also conformed to the requirements of FATCA due to the financial havoc that non-compliance of the statute may create on a domestic level. This conformity is because a 30% withholding tax by the US Government is a fatal step than conforming themselves to the statute.

The FATCA is expected to close the loopholes and tax evasion schemes used by US citizens and entities with the view of substantially increasing the tax receipts over time since; the implementation is only a one-time process; whereas, the revenue receipts may not stop flowing in!

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